When it comes to investing, one of the most common mistakes made by novices and professionals is attempting to catch the bottom of a stock. This act is commonly referred to as trying to catch a falling blade or knife.
Many businesses go through periods of extreme success and stressful lows financially, with the market’s response causing stocks to follow in the same pattern. Catching the falling blade occurs when people believe that a rebound might occur when there is no definitive proof in that assumption.
An Example from Nokia
In 2012, Nokia announced they would lay off 10,000 people in an effort to change the market sentiment of the company. The company used to be the largest cell phone manufacturer in the world, but witnessed a significant fall from the top at the emergence of more sought-after cell phone providers. This information was not known back in 2012, so many investors purchased stock hoping the company would reclaim its title. They did not, and the result was stock falling from $41 a share to $2.50.;
Given how well Apple and Android were being received by consumers, most money managers and stock brokers argued against their clients investing their money, but only a small percentage of traders utilized the assistance of professionals. In order to avoid a similar mistake, do not base your decisions on the notability of a brand. Thoroughly research trends in the company and industry as a whole. This lets you get closer to the truth of a company’s decline.
Stock Going Down Is Not Always a Buying Opportunity
Research in Motion (RIM) recently went through a difficult period where their over 40 percent smartphone market share turned into a figure slightly over six percent. This was not seen in one catastrophic fall. It was the result of a multitude of small but steady decreases over a few years. As the company’s stock kept stepping down, investors thought each decrease was a buying opportunity.
The company was one of the biggest cell phone manufacturers of all time, and, because the decreases were so small, there was a real reason to believe a turnaround was possible. $80 shares transformed into $10 shares. This, however, turned into a great lesson in historical examination of a company’s stock.
Observing the falling and rising of share prices over the past few months is always more reliable than the past few weeks. There are many investors who base their decisions on a minute by minute basis, leading to a lack of understanding in trends.
The Common Denominator in Investors' Mistakes
Even though the market has proven its unpredictable qualities countless times, many investors believe they can see into the future, or trust in emotional quantifiers, as opposed to concrete evidence. This complication arises every time human nature interacts with a facts and figures enterprise. People believe they have some insight other investors do not, and they step in prematurely, before adequate research is conducted.
In both the Nokia and RIM situations, the same scenario is evident in which profitability, market share, and gross margins were declining. Instead of believing that the losses were due to a product that was behind the innovation curve, investors were certain these were but lucrative hiccups in consumer trends. It is always better to base decisions on evidence and historical examples, as opposed to a hope or feeling. Objectivity is always a better approach to entering the stock market.
Consistently ask yourself when making an investment whether your decision aligns with data. Everyone has opinions on what products and businesses are great, but the stock market is a game of averages, from exponentially large consumer audiences. Your personal beliefs and opinions on a company have almost no relevance in investing. Educational resources like purefinancialacademy.com preach that fact-based decisions are the only ones that belong on Wall Street.
RIM is a great example of this error. The management at the BlackBerry manufacturer inspired a belief that the company was better than every other cell phone maker. Through advertising and consumer interaction, the company was able to disguise the true reality of their value and sales. RIM focused more on their perception of their product, and less on their innovation..
Develop your own opinion of the value of a stock through your own research from different sources outside of the enterprise’s advertising and mission statements. To avoid catching the blade and other investment mistakes, understand the industry, corporate structure, and products as fully as possible.